If you own a closely held business, chances are that it takes up a big chunk of your balance sheet, even though most of its value can't be found in bank accounts and liquid investments. Have you ever stopped to think about what would happen to that business and its value if you die?
If you're wondering what to do, the answer may be a "buy-sell" agreement funded with life insurance. It can potentially save your business and give your heirs a secure income. If you don't do it, here's what could happen and has happened to many small-business owners:
- If you have a sole proprietorship, the business shuts down because there is no one else in the business capable of (or interested in) running it. Additionally, when your heirs try to sell it, there aren't any buyers because you're not there to run it.
- If it's a partnership, the business continues, but those running it will have to pay someone to replace you, maybe at a higher salary than you were paid because you were building equity. This puts a double strain on the business -- it is paying more to someone who knows less about your business and may require a long learning curve to get up to speed.
- A member of your family takes your place in your solely owned business but knows little or nothing about running it and it fails. Or, if you have a partner in a partnership or in a corporation with co-shareholders, replacing you with even a knowledgeable family member may cause tension for the remaining co-owners. A family replacement can be more of a liability than an asset.
- The IRS determines that the value of your business is twice what you could sell it for and your estate has to pay taxes on that value even though there is little or no cash.
- Your family tries to sell your share of the business to your co-owners, but they don't have the money to buy it outright, and paying for it over a period of time could put a strain on the business's cash flow.
The bottom line? The value of your business could be significantly diminished. Further, the money your heirs were counting on to support them -- to pay for their retirement and perhaps for college -- may not exist. It will be even more painful if you had been planning to keep your business running until one of your children was old enough to take over.
What You Can Do
The solution to all of these scenarios may be a binding buy-sell agreement that says if you die, someone else is obligated to buy your interest. That someone can be an actual person or people, such as current co-owners or even competitors. It could be the company itself.
With a buy-sell agreement in place, upon your death your estate can sell the business and receive the cash, the business won't go down the tubes, and you may have saved the livelihood of your partners or co-shareholders.
A key point to setting up the transaction correctly is to make the buy-sell agreement binding for all parties, so the buyers don't have the option of backing out after your death. Also, if done correctly, the IRS has to accept the value of the business interest that has been stated in the agreement. The costs involved in a buy-sell agreement include professional fees and insurance premiums (premiums will depend on your health rating and insurability). After all, the alternative could be that nothing will go to your family; not only would they lack the money they were counting on, they would wonder why you did not "take care of business" while you were alive. In the end, if all is done properly, the life insurance proceeds will go to your estate, your new buyers will receive your interest and the business will carry on without a cash drain for years to come.
Your heirs and business partners will thank you.